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How Are Bonuses Taxed In California

There are a lot of businesses that give out bonuses during the winter holidays to show appreciation to their employees. Other businesses may use bonuses as incentives to boost sales or production. 

While most employees would prefer a raise instead, a bonus is a compromise that helps out both parties. The employee gets some extra cash to take home, and the employer only has to make a one-time payment. 

One of the most frustrating things about bonuses is the way they are taxed. It’s not enough of a headache that you should refuse the bonus, but you’ll have to pay taxes on it when you file your returns. 

If you are unsure of how to pay taxes on a bonus, you may want to talk to some tax experts and get their advice. The last thing you want to do is end up owing money to the IRS because your job rewarded your hard work with a bonus. 

How Are Bonuses Taxed?

The state tax rate of California is the highest in the country at 10.23%. 

A bonus will be taxed the same way regardless of why you receive it. The IRS requires all bonuses to be subjected to income taxes, but the total isn’t simply added to your annual income. Instead, your bonus is classified as supplemental income and will be taxed differently. 

The federal tax rate for bonuses under a million dollars is 22%. A bonus of more than a million dollars will be taxed at 37% which is the highest rate possible. These federal tax rates are flat and will apply to everyone in the country. However, each state will also tax the bonus and have its own specific rates. 

These are the supplemental income tax rates for each state in America:

  • Alabama: 5.00%
  • Arkansas: 6.90%
  • California: 10.23%
  • Colorado: 4.63%
  • Georgia: 2.00% – 5.75%
  • Idaho: 6.925%
  • Illinois: 4.95%
  • Indiana: 3.23%
  • Iowa: 6.00%
  • Kansas: 5.00%
  • Kentucky: 5.00%
  • Maine: 5.00%
  • Maryland: 5.75%
  • Massachusetts: 5.00%
  • Michigan: 4.25%
  • Minnesota: 6.25%
  • Missouri: 5.40%
  • Montana: 6.00%
  • Nebraska: 5.00%
  • New Mexico: 4.90%
  • New York: 9.62%
  • North Carolina: 5.35%
  • North Dakota: 1.84%
  • Ohio: 3.50%
  • Oklahoma: 5.00%
  • Oregon: 8.00%
  • Pennsylvania: 3.07%
  • Rhode Island: 5.99%
  • South Carolina: 7.00%
  • Vermont: 6.60% to 11.1%
  • Virginia: 5.75%
  • West Virginia: 3.00% – 6.50%
  • Wisconsin: 4.00% – 7.65%

Nine states have no personal income taxes, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

There is also no supplemental withholding rate for Arizona, Connecticut, Delaware, Hawaii, Louisiana, Mississippi, New Jersey, and Utah. 

What Constitutes A Bonus?

A bonus is any amount of financial compensation that is greater than the normal payment expectations of an employee. Businesses have been known to award bonuses to employees of all levels for a variety of reasons. 

A bonus may be used to reward specific achievements, show gratitude to employees, or entice prospective employees to join the company. 

There are a few different types of bonuses commonly doled by a business:

Incentive-Based Bonuses

Common incentive bonuses include signing bonuses, referral bonuses, and retention bonuses. 

A signing bonus is used by a business in order to convince a job candidate to accept the position. These are specially used for top-level talents that are being pursued by the competition. 

Offering a bonus instead of a salary bump is more beneficial for the business. They will save money in the long term and increase the odds of landing the prospective employee. 

A referral bonus is offered to current employees that recommend candidates that fill open positions within the company. The bonus will provide an incentive for an employee to help fill the position with a high-quality prospect. 

A retention bonus is used to prevent crucial employees from leaving the company. These are especially common during times of financial turmoil for the business or changes in leadership. 

These bonuses signal that the employee is a valued member of the team and their job is secure.

Performance-based Bonuses

A performance-based bonus is a way for a business to reward its employees for going above and beyond their responsibilities. They are usually offered at the end of large projects or fiscal quarters. The bonus may be extended to an individual, team, department, or entire staff of the company. 

There are some businesses that build specific bonus structures into the contracts of their employees. Profits earned during the year are shared amongst the employees based on their standing in the company. 

The more common method of performance-based bonuses comes in the form of an annual bonus. Most companies will offer a cash bonus, gift card, stock certificates, holiday party, or words of appreciation. 

How Can You Pay Fewer Taxes On A Bonus?

Bonuses are treated as income and will be taxed based on federal and state tax rates. However, there are a few ways that you can reduce your overall tax obligation. 

The best option would be to consult with a tax professional who can review the details of your specific situation. They can look for a few legal ways for you to lessen your tax burden. There are two different options available: reducing your gross income or increasing your deductions. 

Contribute To A Retirement Account

Making contributions to a tax-deferred retirement account can lower your gross income. Most people are offered a 401(k) retirement account by their job, or they’ve established an individual retirement account (IRA). 

There are limitations to the total amount that you can contribute, but any amount will lower your taxable income so your taxes will be lower. The limit for contributions to a 401(k) is $19,500 and for an IRA is $6,000.

Contribute To A Health Savings Account

Depending on your health plan, you might be able to contribute to a health savings account (HSA). Donating money to an HSA will lower your gross income, reducing the total amount you’ll be taxed. 

Another benefit of having funds in an HSA is that they can be withdrawn to cover medical expenses without incurring any tax penalties. There is a limit to how much you can donate to an HSA in a single year. 

The cap is $3,600 for an individual and $7,000 for a family.    

Donating to a charity can help to lower your taxable income when you file a return. The total amount of the donation can be deducted from your gross income as a deduction. It’s important to note that this option is only a possibility if you itemize your deductions. 

Taking the standard deduction prevents you from writing off charitable donations. You can donate up to 50% of your adjusted gross income annually. If the charity is considered legitimate by the IRS, then the overall sum can be deducted from your gross taxable income. 

How Do You Report A Bonus On Your Taxes?

If you are unsure how to report a bonus on your tax return accurately, you should talk with an accountant. Failing to report a bonus properly could lead to discrepancies on your return and could trigger an audit. 

Most employers will help you by including the bonus amount in the W-2 that you receive in January. The information will be included whenever you copy the total onto your tax return before filing. 

Your employer might not include the bonus in your W-2 information, and it will be up to you to report it. This is usually the result of receiving a cash bonus. You would need to report the bonus on line 1 of Form 1040. 

Can You Refuse A Bonus?

Getting a bonus could potentially bump you up into a higher tax bracket. Instead of being subjected to more taxes, you may just decide to refuse the bonus. It’s important to note that tax brackets won’t affect the entirety of your taxable income. 

If a bonus takes you past the threshold of a bracket, the new tax rate will only be applied to the money over this limit. 

For example, if a $3,000 bonus elevated your gross income from $38,000 to $41,000 then you would be in a different bracket. 

You would pay the standard 12% tax for any amount up to $40,525 and 22% on the amount that’s over $40,525. 

So even if a bonus bumped you into a different bracket, you would still be taxed proportionally. 

The Takeaway

Getting a bonus can be a very exciting reward for an employee that also benefits the company. You will still need to pay taxes on a bonus, but they will be proportional based on your tax bracket and state. 

Failing to report a bonus could get you in trouble with the IRS, so make sure you include them on your return. 

There are a few ways that you can lower your tax obligations and reduce the total taxes on your bonus. Consulting with an expert at Coast One Tax Group can provide you with a few options that might save you some money and keep you out of trouble with the IRS.

SOURCES:

Raise vs. Bonus for Your Small Business Employees | Investopedia

How Bonuses Are Taxed | The Balance

State supplemental income tax withholding rates for 2020 | Tax News

Bonus Definition | Investopedia

2021-2022 Federal Income Tax Brackets & Tax Rates | NerdWallet